Spring is in the air, the banking crisis appears to have been contained for the time being and it’s time to take a look at how the real economy is faring.
Next week brings the all-important U.S. monthly jobs report, as well as a final read on business activity in March, a crucial rate decision Down Under and, possibly, the chance for Treasuries and the dollar to regain some stability after March’s market madness.
Here’s a look at the week ahead in markets:
GOTTA HAVE A J-O-B
After weeks of worry about the banking sector, Friday’s U.S. employment data shifts the focus back to the macro picture. Traders will be keen to learn whether the Federal Reserve’s barrage of rate increases is cooling the economy.
Views on the likely trajectory of rates have once again diverged. Fed officials project rates will remain around current levels for the rest of 2023 to help slow growth and fight inflation. A strong jobs number would support that view.
Economists polled by Reuters expect a rise of 240,000 in March, so anything short of that would suggest the Fed could cut rates this year as tighter monetary policy bites and growth softens.
That outlook – bolstered by the tumult in the banking sector – is one held by many investors. Futures markets are pricing a roughly 50-per-cent chance of a 25-basis-point rate increase at the central banks next meeting, in May, followed by cuts throughout the rest of 2023.
NO SPRING IN ITS STEP
Spring is finally here, and the dollar has posted its weakest performance for the first quarter since 2018, falling 1.3 per cent, despite the swell of safe-haven demand the banking crisis unleashed.
Historically, Q1 is the strongest for the dollar. On average, over the last 50 years, the dollar has gained 1.1 per cent between January and March, while Q4 is its weakest, with an average drop of 0.8 per cent.
Fund managers slashed their bearish positions during February’s 2.5-per-cent rally, but they’re still sitting on a short position of US$5.289-billion, according to Refinitiv data.
In theory, those bearish bets could be bought back and even flipped into bullish ones.
Traders are short, but not that short. With maybe one more rate hike priced in, inflation cooling and the banking crisis contained – for now – there don’t seem to be too many reasons to spring for the dollar.
SHAKEN, MR. BOND?
Two-year U.S. borrowing costs are about to post their sharpest drop since 2008 in March as banking turmoil wiped out bets on further central bank rate hikes.
They dropped over 60 basis points, but don’t forget they rose by a similar amount in February, when all the focus was on sticky inflation and a red-hot labour market.
Bond markets were whipsawed this quarter and trading became so challenging that investors drew parallels with the market environment during Russia’s invasion of Ukraine and the COVID-19 pandemic.
Now, just as traders were settled to the idea that rate hikes would soon end, above-forecast German data on Thursday let the inflation genie back out of the bottle, sending bond yields sharply higher.
Until markets get a clear sense of whether financial stability or inflation will drive central banks going forward, expect more turbulence.
REASON FOR PAUSE
A recent run of tepid Australian data – along with continued risks of a banking crisis – have seen markets price out pretty much any chance for a rate hike on Tuesday by the Reserve Bank.
In fact, there’s even a sense that the 10-month tightening campaign may have run its course.
A report on March 28 provided more evidence of tighter purse strings. Consumer price figures a day later backed the case that inflation has peaked, rounding out the data points that RBA officials said they would watch closely ahead of their decision.
Across the Tasman, bets are still for the Reserve Bank of New Zealand to hike by another quarter point on Wednesday, and traders place a good chance of the same again by July.
But markets don’t expect the additional move needed to reach the central bank’s own projected 5.5-per-cent peak.
RECESSION, OR RELIEF?
Turmoil in the banking sector, following the collapse of U.S. lender Silicon Valley Bank and Credit Suisse’s rescue merger with UBS, risks global banks adopting more austere lending standards as they strive to prove they are well-capitalized.
Monthly purchasing managers indexes, the real-time indicators of business conditions, are due out in the first week of April. The early “flash” version of this survey for the U.S. showed manufacturers’ new orders had fallen for the sixth straight month.
Conviction is now building among investors and central bankers that banking stress and a potential follow-on credit crunch make a hard landing for the world’s largest economy more likely.
The optimistic take for the equities market at least is it brings central bank interest rate cuts into view, with stockpickers focusing on high quality, defensive companies, in industries such as health care and consumer staples, that may weather a recession well.
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